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European stocks soar and bond yields dive on rescue plan, but euro rally runs out of gas

May 10, 2010 | 11:24 am

Europe’s shock-and-awe rescue plan to keep its financial union intact is having the effect that policymakers were hoping for, sending stock and bond values rebounding dramatically Monday.

But there already is one sign of doubt creeping in: The euro currency is trading well off its highs reached earlier in the day.

The European Union, the International Monetary Fund and the European Central Bank late Sunday hashed out a massive bailout plan that will include nearly $1 trillion in loans and loan guarantees for the weakest countries in the euro-zone.

The goal: persuade global investors that debt-ridden countries, including Greece, Portugal and Spain, won’t blow up and take the rest of Europe down with them.

Daxtraders For its part, the European Central Bank agreed to directly buy the bonds of euro-zone countries, stepping in as the lender of last resort -- just as the Federal Reserve did last year in the U.S. mortgage-backed-securities market.

The EU aid package and the ECB’s bond-purchase commitment triggered a massive rush of money back into stocks and bonds, which had been hammered for the last three weeks. Many traders who were “short” these markets no doubt were trying to cover those bets Monday.

Spain’s main stock index soared 14.4% for the day to close at 10,351. But after last week’s 13.8% plunge, Monday’s rebound still left the Spanish market below its level on May 3 -- and down 13% year to date.

Stocks were up 11.3% in Italy, 9.1% in Greece and 5.3% in Germany.

In the bond market, the annualized yield on the Greek government’s two-year notes dived to 7.53% from 18.27% on Friday. Portugal’s two-year note yield tumbled to 2.95% from 6.05% on Friday.

Still, Moody’s Investors Service put a damper on the markets’ party by warning that it would probably be lowering its credit ratings for Greece and Portugal in the next month or so, despite the rescue plan.

The euro, which had fallen to a 14-month low of $1.262 on Thursday, shot as high as $1.309 in Europe on Monday. But in U.S. trading, the euro had come well off its highs by about 11:15 a.m. PDT, when it was trading at $1.282.

A popular view in currency markets is that the rescue buys time for the battered euro, removing the immediate risk of a further downward spiral in European financial markets. Longer term, however, the euro’s outlook remains dicey.

Alan Ruskin, head of currency strategy at RBS Securities in New York, said the huge rescue program exposed Europe’s monetary union as “hopelessly compromised.” Long-term, that is likely to give big investors such as central banks and sovereign wealth funds “pause for thought when considering reserve alternatives to the U.S. dollar,” he said.

-- Tom Petruno

Photo: German stock traders in Frankfurt on Monday. Credit: Mario Vedder / Associated Press